Tuesday, June 12, 2007

Inflation in China

This news story is making headlines in the business press this morning:
China's Inflation Accelerates, Adding Rates Pressure

June 12 (Bloomberg) -- China's inflation accelerated at the fastest pace in more than two years in May as pork prices soared, increasing the likelihood that interest rates will be raised.

Consumer prices rose 3.4 percent from a year earlier, the National Bureau of Statistics said today. That was more than the 3.3 percent expected by economists. April's inflation rate was 3 percent, matching the central bank's 2007 target.

Meat prices surged 26.5 percent, helping to push inflation above the target and adding to concern that the world's fastest- growing major economy may overheat. Inflation is outpacing returns on bank deposits, encouraging households to put money into a stock market that the government is trying to cool.

"Today's number and the stock market for the past few days make a stronger case for a rate hike," said Wang Qing, chief China economist at Morgan Stanley in Hong Kong.
The reason that this news is of such interest to the US is because of the implications it holds for China's monetary policy, which faces increasing pressure to cool down the Chinese economy. The classic ways to do that would be to raise domestic interest rates, and/or to allow the currency to appreciate against the dollar. Either of these steps could cause a reduction in official Chinese purchases of US bonds, thus contributing to a rise in interest rates in the US.

On the other hand, in the past the Chinese authorities have used more quantitative means to control the speed of the economy - i.e. urging (commanding?) more or less lending by the banking sector. That route implies a smaller impact on the US economy (US interest rates would be less directly impacted), which is why observers in the US have been paying close attention to every move by the Chinese monetary authorities.

One thing is for sure, though: month by month, it seems increasingly clear that China's government will need to take bigger steps to cool the economy than they have so far.

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